Microsoft hopes its dinosaur has a powerful bite

Windows Vista may look like a dinosaur in the new age of lightweight online services and Web 2.0 software development but it will certainly come with a powerful bite.

That is the hope on Wall Street and among investors as Microsoft prepares finally to take the wraps off a software product that has come to symbolise the software giant’s struggle to adapt to the newer, faster-moving world of the internet.

Conceived five years ago and arriving two years later than first planned, Vista is a gargantuan project that was hampered by excessive ambition. Microsoft finally dropped a core part of the new architecture it had planned for the system to end the delays, prompting Steve Ballmer, chief executive officer, to promise that the company would never again commit itself to such an ambitious, one-off overhaul.

Yet Vista also represents the most important new product cycle in Microsoft’s original core business, of PC operating systems, since the launch of Windows 95. Back then, there were about 100m PCs in use around the world: that number has since grown to 800m, creating a massive potential market for both Vista and a new version of Office, both of which will be unveiled formally in New York on Thursday.

As with all releases of Windows and Office, the biggest competition for Microsoft will not come from new rivals such as open-source system Linux or online services offered by Google and others but from the inertia among PC users who consider their existing software to be good enough.

Consumers are typically the first to buy a new PC operating system, with a few early adopters drawn by new graphics or features that promise a better experience. More significant for Microsoft, though, will be the pace at which large corporations make the switch – something that typically only comes 18 months or two years after launch, as companies wait for early bugs to be ironed out and go through the long process of testing their many applications on the new system.

The massive job of selling the benefits of Vista to large companies begins in earnest with Thursday’s formal launch. But for big companies, “the cost of the upgrade is going to exceed the benefits of the operating system,” warns Michael Silver, an analyst at Gartner. That means, he adds, that to get value from Vista, companies will “need to go beyond the operating system to improve the manageability” of their PCs.

Vista makes it easier for IT departments to manage large numbers of machines centrally, reducing the amount of costly time spent dealing with each user’s machine. To get those benefits, companies will have to change the way they operate, often by taking control of the PC away from users – something that some office workers could object to, according to Mr Silver.

Translating this massive software renewal cycle into hard financial projections, meanwhile, depends on a number of factors.

One is how many PC users choose to upgrade by installing Vista on their existing machines. This will be a small percentage, since most only upgrade when they buy a new PC, but it could still have a significant impact on Microsoft’s revenues. This could add $800m-$1bn to Microsoft’s revenues in the first 12 months, “but it’s possible it could be twice that,” says Rick Sherlund, software analyst at Goldman Sachs.

A second question is how successful Microsoft proves in persuading customers to buy new “premium” versions of the operating system. Consumers, for instance, will have to pay extra for a version that comes with “Aero,” the new user interface that adds a glassy finish to the graphics.

Lifting the average selling price for Windows by $5, from the $80 or so it currently makes, would add 5 cents a share to its earnings by 2008, according to Charles Di Bona, software analyst at Sanford C Bernstein.

A third factor will be whether Vista stimulates a new PC upgrade cycle. Most companies do not tie their PC purchases to Windows product cycles, yet the length of time since the last major release may have left some pent-up demand that will drive more PC upgrades than would otherwise have been the case, according to analysts.

For Microsoft, all this adds up to an expected reacceleration in Windows PC revenues – a division that now accounts for only 30 per cent of its revenues - at the same time that other large new products cycles are set to peak. As a result, overall growth could “settle in the lower- to mid-teens,” says Mr di Bona. That may not come close to Google-style growth but few other companies with revenues that will top $50bn this year will come close to matching it.